BlogReturn to The JAM Blog
Saudis decide to borrow rather than cut production (in order to force up prices)
August 6th, 2015, 5:00 PM
0 LEAVE A COMMENT PRINT THIS POST
Oil rigs - land
The U.S. commodities markets looked past huge news on oil supplies, today August 6, in favor of a focus on very near term news pending for tomorrow. After a relatively—if downward trending (no surprise)—uneventful day for oil prices today, August 6, I’d expect more volatility tomorrow on the July jobs report from the U.S. Bureau of Labor Statistics.
That’s because
economists are more all over the place than usual with estimates of top tier companied putting the increase in jobs at anywhere from 185,000 to 250,000 net new jobs for the month
the Federal Reserve is thinking—strongly—about an initial increase in interest rates at its September 17 meeting. A reading of 185,000 jobs in July is weak enough so that financial markets will raise their hopes that the first increase will be put off until December or even 2016. A reading of 225,000 or above would increase worries that September remains in play.
West Texas Intermediate, the U.S. benchmark, fell another 1.1% to $44.64. The Brent benchmark edged 0.02% lower to $49.58 a barrel.
I call that an uneventful day because yesterday the government of Saudi Arabia announced that it would sell $27 billion in bonds to make up, in part, for the plunge in oil revenue as the price of oil went from $115 a barrel to $50. The Saudi government requires oil of $105 a barrel to balance its budget. The country has spent down an estimated $65 billion in foreign exchange reserves (leaving the nation with only $672 billion) to continue subsidies and social spending at pre-oil-plunge levels. The bond sale, yesterday’s announcement said, began with a $4 billion offer in July, the first time Saudi Arabia has sold debt since 2007.
Why is this decision to sell bonds so important to oil prices?
Remember that one reason U.S. producers in domestic shale geologies have been able to increase production so quickly and why they’ve been so resistant to cutting production even as oil priced plunged was that U.S. producers could borrow to fund temporarily unprofitable operations.
Plenty of banks and investors in junk bonds were willing to lend to U.S. shale producers when oil was at $110 or even $90 a barrel on prospect for future cash flows as production ramped. That enthusiasm has waned along with oil prices and the collapse in the prices of oil patch junk bonds.
Think banks and bond buyers will have any doubts about buying Saudi debt, backed as it would be by 268 billion barrels of proved reserves (end of 2014 figures from the U.S. Energy Information Agency)?
The Saudi’s can’t borrow on infinite amount of money, obviously, even on their massive reserves, but the Saudi government’s decision to go to the debt markets to cover its oil revenue shortfall removes a huge amount of pressure on the Saudi’s to cut production in order to force up oil prices.
That is the strategy in these oil price plunges traditionally adopted by Saudi Arabia as the world swing producer. When oil prices fell, the Saudi’s would cut production to push the price per barrel back up. When oil prices climbed to a level that threatened to damp global demand or speed up the transition to other sources of energy, Saudi Arabia would increase production.
Not this time. The Saudis seem determined to fight the battle this time not over price but over market share. Their strategy is to produce all out to prevent U.S. shale producers or Iran from taking market share.
A decision to sell bonds means that the Saudi’s have lots and lots of money to use in pursuing that strategy. If you were thinking that we might see the end of oil price bust by the close of the year and that supply and demand were headed into balance in early 2016, I think you need to revise your thinking. With the Saudi’s able to produce full out well into 2016 and with U.S. producers showing almost no decrease in production, I think the end of the price bust has been pushed well off into mid or late 2016 and that we likely to see a rebalancing of supply and demand no earlier than the end of 2016.
In other words, the oil price collapse just got deeper and longer.
Tags: end of oil plunge | oil | oil stocks | Saudi oil strategy
Return to The JAM Blog
Be the first to comment on this post!
Leave a Comment